We are upgrading our recommendation on the shares of Assurant Inc. (AIZ) on the back of higher earnings expectations led by share repurchases and positive results from its Solutions and Employee Benefits segments. The recent dividend increase also makes us optimistic of Assurant’s solid cash generation capabilities.
 
The top line at Assurant Solutions, which constitutes the largest percentage of total revenues, grew throughout 2009. We expect the segment to maintain the same trend in 2010. Though results in the U.K. have been disappointing of late, the company has taken several steps for a turnaround in the international arena. This includes the addition of several new clients internationally, totaling $100 million in production.

These actions are expected to tone down the international combined ratio by 1% to 12% per quarter throughout 2010. Moreover, management will begin to execute a two-year plan to streamline its organizational structure, which when completed will release $75 million to $150 million in capital.
 
Assurant’s Employee Benefits segment has been pressured by persistent economic challenges in the small group sector, leading to higher lapse rates and lower premium growth on in-force policies. Since there have been few new employee additions and modest wage growth, premium income from the segment will remain under pressure in the near term.
 
Despite top-line pressures owing to limited job growth among the small employers within the Employee Benefits segment, the company is finding other ways to grow. Recently, its dental network relationship with Aetna Inc. (AET) has been extended until 2012. New client additions at Disability RMS and Shenandoah Life Block are expected to add $100 million to revenues in 2010. These combined with expense reduction efforts are expected to improve profits in 2010.

But Assurant Specialty, which derives most of its premium from creditor-placed homeowners’ insurance, is witnessing a decline in outstanding mortgage loans. This trend is expected to continue until the mortgage market rebounds. As a result of the fallout of the housing crisis, the company is suffering from lender consolidation, less mortgage originations and fewer new home sales, all of which culminate in fewer loans tracked by the company.

Moreover, a growing government participation in home mortgages is restraining the company’s market share. Therefore, earnings from this segment are expected to reduce by $10 to $20 million (after tax) in 2010, which is expected to dampen the overall results.
 
Also, Assurant Health has traditionally been underperforming, faced by a challenging environment. As such, it has concentrated on this business by enhancing its product offering and changing its pricing and plan designs. These initiatives are expected to improve margins in the near term. However, we remain concerned with the long-term implications that the recently enacted Health Care Reform Act might have on the company. A reduction in earnings might lead to goodwill impairment in this segment, which would compress the bottom line.
 
Assurant is conservatively placed with respect to its investment portfolio. It has below-average investment allocations to riskier assets such as commercial real estate, European sovereign debt, BBB bonds and subprime/Alt-A securities. We believe this conservative portfolio will cushion earnings if the macro conditions deteriorate.

With the settlement of the SEC investigation into the reinsurance agreement, Assurant has also resumed its share repurchase with $770 million of buyback authorization, which it expects to utilize over the next few years. The company repurchased $109 million of stock in the first quarter of 2010. Given the current excess cash, we expect a high level of buyback in the near term, which would in turn add to the earnings per share. Assurant has also raised its annual dividend by 7% during May 2010, marking its sixth consecutive dividend hike since going public in 2004.

Moreover, the financial position of Assurant remains strong with $4.8 billion of equity capital and $480 million of deployable capital at the end of March 31, 2010. There is no debt maturing until 2014, and the overall asset has a leverage of 2.7x, a 17% debt-to-equity ratio, and a fixed interest coverage ratio at over 10x. These metrics and free cash flows generated by the business all indicate a solid financial position.
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